A common misconception about FHA loans is that they are for low-income families but the fact is that there is no minimum or maximum income requirement; however, when approving an FHA loan, we want to make sure that the borrower's monthly debt-to-income ratio is not too high. Although we do allow some borrowers (those with compensating factors) to spend up to and even over 50 percent of their gross monthly income on their combined monthly debts, we prefer to keep this ratio at or below 45 percent. Surprisingly, mortgage guidelines will often qualify borrowers for higher monthly payments (i.e., higher loan amounts) than they are comfortable paying. Homeowners should be sure to review their budget and be clear as to their comfort level when meeting with their mortgage professional.

There are many advantages to FHA loans but perhaps the most popular and significant advantage is that these loans will allow a homebuyer to borrow up to $729,750 on a home priced up to $756,000. No other loan program will allow limits this high! The biggest downside to FHA loans is that they require both an upfront and a monthly mortgage insurance premium and these premiums can be twice as high as those required by conventional loans.

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With minimum down payments on FHA loans as low as 3.5 percent, any decline in a home's value leaves homeowners upside down which for some provides little incentive to keep making the payments when a family's income declines. Due to this factor and the fact that FHA loans are more lenient on credit history than conventional loans, the FHA loan insurance program has been losing money due to defaults and foreclosures. In response FHA is increasing the premium on its mortgage insurance sometime in 2013. FHA loans currently require the borrower to pay the monthly mortgage insurance premium for a minimum of five years, after which time, the premium may be waived if the loan to value ratio has fallen to 78 percent; however, effective next year, FHA loans will require borrowers to pay the monthly mortgage insurance premium for the life of the loan. The premiums will also be going up next year.

The mortgage insurance premium effectively raises the interest rate 1.25 percent. When adding the mortgage insurance premium to a 30 year fixed rate for an FHA loan at 3.25 percent, the real rate is closer to 4.5 percent. The upfront mortgage insurance premium has been 1.75 percent of the loan amount. On a $400,000 loan, that amounts to $7,000 but the good news is that it can be financed by adding that fee to the base loan amount; therefore, the new loan would become $407,000.

There are numerous considerations when exploring mortgage options; borrowers are advised to consult with one or more mortgage professionals who are experienced in both FHA and conventional loans before making a final decision.

Local mortgage consultant Peter Boutell has been writing a weekly column for the Sentinel since 1995. Send questions to 'Lending a Hand,' 1535 Seabright Ave., Santa Cruz, CA 95062, fax them to 425-1044 or email them to peter@santacruzhomefinance.com. Archived columns are available at www.peterboutell.com.